Economic ignorance in the Wall Street Journal shouldn’t be too surprising. After all, these are the guys that forget the law of supply and demand applies to labor markets. But the scale of ignorance in “journalism major” Holman Jenkins’ recent editorial is staggering. He says:
No wonder economists of diverse ideological stripes are lining up behind a taxpayer bailout of homeowners and lenders, fearing the alternative is a global inflation crisis. But another option has hardly been considered in Washington, though it’s old hat in the sticks: Using tax dollars to buy and demolish foreclosed, unoccupied or half-built houses in selected markets.
This isn’t as wild-eyed as it sounds. Ben Bernanke pointed out in a footnote to a recent speech that such programs already are at work in the Midwest. “In highly depressed housing markets, the worst-quality units are often demolished to mitigate safety hazards and reduce supply.”
This is a variation of the hoary idea that a “war is good for the economy,” itself a species of the broken window fallacy. Consider his reasoning. Home prices are too high. Existing homes have value. But that value is stagnant or declining because of too much inventory is on the market. Some people–like young people and renters–benefit by lower prices. Other people–home owners and banks–benefit from higher prices. Therefore, the government should destroy homes to raise prices. That’s his argument.
Lateral economic transfers–in this case from home owners to would-be home owners through falling market prices–usually do not concern economists. Economists are concerned with wealth maximization for the whole society, which generally consists of getting willing buyers and sellers together at some price: any price.
Destroying homes to raise prices is senseless and, as the destruction itself visibly attests, not wealth maximizaing. Underused and foreclosed home assets still have value. Of course, as asset values drop, some banks and holders of mortgage-backed securities will be under-securitized and left holding the bag for bad notes. But no bank would willingly destroy its own security in the form of an undervalued home. Such a hair-brained scheme would cause the bank to lose not only the differential of the home value and the face value of the mortgage note, but the value of the underlying security as well.
Government-created artificial scarcity is an old trick long denounced by economists as wealth-reducing on net. Since when can assets not be sold at a loss? What principle says that banks and speculators who made bad bets can’t be held to account for their improvidence (or bad luck)? Who said that home owners are more worthy of their wealth than would-be homeowners and renters? Why does the Journal only cheer the law of Supply and Demand when it raises the prices of things that the Journal’s staff and customers already own? (Well, that last question answers itself.)
The author cites housing destruction in Baltimore as this enlightened process in action, but the example is a bad one. It’s one thing to say a vacant, old home is a nuisance that should be bulldozed for the common good, but it’s quite another to destroy a perfectly good assets to affect market prices. A new home, unlike a crack house, takes minimal investment to be maintained. It can always be sold at a loss or even given away if the cost of maintenance is too high. The faster housing prices drop, the faster people waiting in the wings with capital can get a home mortgage and buy both a home the old fashioned way, acquiring housing and an appreciating asset in the process.
The idea of destroying assets to raise prices comes in part from the mistaken view that deflation was the big threat during the Great Depression and that assets had to be destroyed to “keep up prices.” In fact, the liquidation process is a key to economic recovery after an inflationary bubble, such as what occurred during the 1920s. This correction requires such drops in prices, and artificially propping up inflated prices through such means as price floors and cartel pricing only delays the inevitable, as witnessed by the elongated depression of the 1930s, where such measures were commonplace.
Subscribe To This Feed
I’m not sure I agree with the editorial’s recommendation, but I know that I disagree with your general criticism of the strategy.
Theoretically, reducing supply as a way to stabilize pricing, can be a sound idea. You see this often in high fixed cost industries, where due to excess supply, there is an ever accelerating push among competitors to reduce pricing to marginal cost, resulting in a downward price spiral.
Think about post 9/11–lots of airlines mothballed planes precisely to avoid this sort of pricing pressure. Or consider horizontal mergers, which often are done to remove supply and to stabilize pricing.
The idea doesnt strike me as crazy.
What the fuck are you talking about? High fixed costs industries are regulated monopolies because they are considered natural monopolies. In other words, they are unique and frequent bankruptcies will result because of marginal cost pricing in a competitive market that will not allow competitors to recoup investments in fixed costs. OK. Fine. I’m not sure I agree this is even true, but this is a widely agreed upon special case with very minimal rises in marginal costs in high volume output.
It has nothing to do with housing, which is a perfectly normal industry with few network aspetcts and where marginal costs in competitive markets generally exceed the average costs. In other words, the market works just fine. If lots of people made errors at the same time, I guess lots of people need to liquidate their bad investments at a loss.
Second, any one can decide to mothball his own assets for lots of good reasons. But in competitive markets something like the milk destruction featured above is unusual; so long as the marginal output can be sold for marginal cost, it makes sense to make and also to sell, even if fixed costs can’t be recouped. It’s quite different when competitors cartelize (as in the farmers’ unions above) to do so. This is usually seen as a means of charging monopoly pricing or, in the case of something like airlines, based on the mistaken idea that it would be a major catastrophe if marginal entrants went out of business. I think such going out of business is perfectly fine, the “creative destruction” Joseph Schumpeter discussed so eloquently.
The reason this doesn’t strike you as crazy, I believe, is that you are knee deep in Wall Street. You have internalized the local cultural view that the goal of the economy is to make rich bankers and stock brokers rich rather than to efficiently allocate resources. The Journal agrees. But it’s a pretty obvious shell game, and the losers from collusion and government subsidization of rich losers like the speculating idiot geniuses at Bear Stearns and UBS is pretty obvious too.
Like I said, I’m not recommending this action, just pointing out that constraining supply (either voluntarily, or through merger) is a pretty common strategy to deal with high fixed cost industries where competition drives pricing below long run marginal cost. The bankruptcy process can exaggerate this effect, where companies file and emerge from an 11 with a lower cost structure (largely by reducing interest expense, by equitizing the bondholders), which in turn drives more ruinous pricing in the industry. I do agree that structurally, it might not make sense to do this with housing, and that the excess supply is better dealt with through pricing than trying to eliminate supply; on the other hand, I could see how it might make sense to remove housing stock in select areas where the externalities from vacancy (e.g., crime, increased policing costs, etc.) are significant.
By the way, I think few Bear Stearns stakeholders feel very “bailed out” by the Fed intervention. Bear was an intervention, but it was not much of a bailout.
In a more just world, lots of these guys would be in cuffs.
The WSJ is a mouthpiece for Big Business, not a journal of economics.
Mostly this is about the fact that inflation is good for some parties, generally those with high debt.
If everyone owned their homes outright, this wouldn’t be an issue. As you point out, lowering the supply of housing won’t improve the economy, it just destroys valuable assets and shifts the costs onto those that haven’t leveraged themselves with a mortgage, as they deal with the resulting inflated rents and home prices.
Ironically, considering the demographics of who tends to own homes and who tends to rent, this is perhaps the most regressive policy we could come up with, but I doubt you would see many Democrats complain.
As often is the case, I see you’ve mostly written the same stuff already, but I am posting this anyway.
I don’t think that destroying thousands of homes would cause the prices of other homes to appreciate, there is simply too much downside momentum in most markets. Destroying the worst maintained home is simply logical, many of the foreclosed on properties would take scores of thousands of dollars of repairs at the least. Many require plumbing repairs due to angry homeowners sabotaging the home, amateur electrical “upgrades” will need to be removed where landlords tried to fit in extra bedrooms in the basement, the walls frequently need to completely sanded and repainted, the floors need to be replaced and the water damage from ongoing plumbing problems will need massive mold remediation.
Many, not most, but a substantial percentage (probably 2-4% of the total foreclosed on properties) of the foreclosed on homes in Loudoun County and Prince William are simply uninhabitable. If the counties were to receive aid they would be able to destroy the single family homes that are in the worst condition, and put in mini-parks. It wouldn’t cause prices to rise, but it might make the neighborhoods with the most foreclosures a little less unpleasant. The problem with this is that the majority of the foreclosed on properties are not single family, they are townhouses or condos which are a bit more difficult to tear down.